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Price dispersion and price indexes

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  • Vera Lucia Fava

Abstract

The traditional theory of price index numbers is based on the law of one price. But in the real world, we frequently observe the existence of an equilibrium price dispersion instead of one price of equilibrium. This article discusses the effects of price dispersion on two price indexes: the cost of living index and the consumer price index. With price dispersion and consumer searching for the lowest price, these indexes cannot be interpreted as deterministic indicators, but as stochastic indicators, and they can be biased if price dispersion is not taken into account. A measure for the bias of the consumer price index is proposed and the article ends with an estimation of the bias based on data obtained from the consumer price index calculated for the city of Sao Paulo, Brazil, from January 1988 through December 2004. The period analysed is very interesting, because it exhibits different inflationary environments: high levels and high volatility of the rates of inflation with great price dispersion until July 1994 and low and relatively stable rates of inflation with prices less dispersed after August 1994.

Suggested Citation

  • Vera Lucia Fava, 2010. "Price dispersion and price indexes," Applied Economics, Taylor & Francis Journals, vol. 42(1), pages 23-36.
    • Handle: RePEc:taf:applec:v:42:y:2010:i:1:p:23-36
    DOI: 10.1080/00036840701579168
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    References listed on IDEAS

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    1. R. G. D. Allen, 1975. "Index Numbers in Theory and Practice," Palgrave Macmillan Books, Palgrave Macmillan, number 978-1-349-02312-7, December.
    2. Spanos,Aris, 1986. "Statistical Foundations of Econometric Modelling," Cambridge Books, Cambridge University Press, number 9780521269124, October.
    3. Matthew D. Shapiro & David W. Wilcox, 1996. "Mismeasurement in the Consumer Price Index: An Evaluation," NBER Chapters, in: NBER Macroeconomics Annual 1996, Volume 11, pages 93-154, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Elena Lasarte Navamuel & Dusan Paredes & Esteban Fernández Vázquez, 2012. "A true cost of living index for Spain using a microeconomic approach and censored data," Documentos de Trabajo en Economia y Ciencia Regional 26, Universidad Catolica del Norte, Chile, Department of Economics, revised Aug 2012.

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